Multinational companies pay taxes wherever they do business. Seems simple enough, right? Possibly on the surface, but if you really drill down into what it means to ‘do business,’ it becomes a little less clear.
Does it mean that you have an office or factory in each country where you pay taxes? What if you have a small sales team that works remotely? Or you provide services to another company that is already established in that country–where do you draw the line?
That’s where permanent establishment comes in.
Permanent establishment (PE) is the official tax term for ‘doing business.’ There are three types of PE that your multinational business needs to be on the lookout for to stay compliant.
What is permanent establishment?
Any company that expands its business across the borders of its home country (residence country) is on the hook for complying with the local laws and regulations for each new country it does business in.
A UK-based company that expands its sales team into other European countries like Sweden or Finland
And this includes following tax regulations, too.
Permanent establishment (PE) is an international tax concept that outlines which business activities qualify the company as having a ‘permanent establishment’ in the country—for tax liability purposes.
There are differences from one locale to the next as to what constitutes a permanent establishment. PE is defined by the tax law of each jurisdiction (such as a country, state, province, territory, or autonomous region).
But in most cases, these ‘business activities’ refer to anything that generates revenue. This might include business services provided by employees or contractors, for example. It may also include profitable revenue from contract negotiations or real estate sales.
The 3 types of permanent establishment
Of course, if a company opens a manufacturing facility or call center in another country, that’s a clear establishment of business in that country.
But that’s not the only way to trigger a PE designation.
This designation can be triggered by three types of permanent establishment:
Establishing PE with a physical presence or fixed place of business
A fixed place of business is when a company buys or rents commercial space for the purpose of conducting business. For example, buying a factory in another country to take advantage of lower labor costs triggers PE.
Other examples of a fixed place of business include:
A retail storefront
A shared service center
A secondary warehouse to facilitate global distribution
A jobsite to mine natural resources
Establishing PE with an agency
Many different industries employ traveling agents. For example, a London-based sales manager that frequently travels to Beijing to negotiate contracts may trigger PE in China.
The specifics vary by country and are generally based on a limit on the number of days that your traveling staff can spend in one country.
In China, the duration for PE is a combined total of six months or 183 days in any twelve-month period. Similar durations are provided in Australia, Brazil and many other industrious countries worldwide.
Other examples of potential agent establishment include:
English as a second language (ESL) instructors
Product placement sales representatives
Global companies are still free to do business on a global scale and to travel to any country where business needs to be conducted. Temporary, preparatory or auxiliary functions will not trigger PE.
Establishing PE with services
Companies like consultants and management firms that operate in many different countries often fit the criteria for PE, as well. But this triggers PE for the service provider—not for the company that uses their services.
Examples of service establishment include businesses that provide service solutions for:
Information technology (IT)
Are there risks associated with PE?
That’s a resounding yes! A PwC survey found that 86% of multinational companies are concerned with growing PE risks as the global business landscape continues to change.
When governments use permanent establishment as a barometer to levy local taxes, it’s up to the individual organization to know where they stand and how much they may be required to pay in foreign taxes based on PE statutes. Companies doing business abroad may one day wake up to a big surprise—and a potentially bigger tax bill—if they don’t take permanent establishment risk seriously.
In particular, it’s easy to blur the lines between temporary work and a permanent presence. Some of the biggest permanent establishment risks come from signing contracts with another in-country business or employing contract workers that perform revenue-generating activities in another country.
With so many types of PE and risks associated with it, it ‘s important for multinationals to fully understand what triggers PE and adhere to the tax implications.
A permanent establishment faux pas can cause severe financial repercussions—and damage your business’ reputation.
The bottom line on the types of permanent establishment
Business doesn’t always look like a physical retail store or manufacturing plant.
This is why it’s so important to understand the various types of permanent establishments and how they’re defined in the places your business is operating.
The best way to ensure that your multinational company is covered from every angle is to work with a reputable global payroll provider who can ensure you avoid hefty compliance fees and fines.
If you’re concerned about your PE risk, get in touch, and we’ll help you evaluate.